Palo Alto Weekly

Editorial: Heading off looming pension crisis

Driven by increasingly higher pension and benefit costs, employee compensation now makes up 63 percent of Palo Alto's General Fund budget, an unsustainable situation that could cripple the city in the years ahead.

But as the Weekly's cover story last week described, it will not be easy to reduce these pension obligations and the potential big impacts on all other parts of the city's budget.

The proportion of dollars paid for employee benefits to salaries is up from 23 percent in 2002 to 54 percent in 2010 and will be 63 percent by fiscal year 2012. Employee benefits alone now comprise 27 percent of the general fund budget.

This snowballing crisis is not unique to Palo Alto, or even small cities. Earlier this week a federal task force found that many states, including California, are facing higher health care costs and underfunded pensions while revenues are sliding backward. Many have resorted to budget gimmicks and borrowing to make ends meet. And some cities, including Stockton and San Bernardino, are opting for bankruptcy as a solution.

In Palo Alto, the pension problem has been growing for years, but high investment returns lulled most municipalities into a false sense of comfort.

For example, in 2007 the city made a deal with the Service Employees International Union to trade a less generous health care plan for a bump in the pension formula that raised the pension benefit from $60,000 to $81,000 a year for an employee retiring with $100,000 a year in income after 30 years of service.

It is deals like this that will push the cost of 2013 pensions to $23.1 million, up from just $3.8 million in 2002 and $2.4 million in 2003. Health care expenses are expected to reach $24 million this fiscal year and to be near $30 million in two more years, three times the $10 million cost in 2002.

A major part of the problem is the lackluster investment performance of CalPERS, the state retirement system, whose most recent report showed a meager 1 percent return, a fraction of its 7.5 percent goal. When CalPERS earnings fall, cities are on the hook to make up the difference in retiree paychecks. This is a double whammy for Palo Alto, which already pays a large part of employee retirement contributions to CalPERS.

And the city's costs are spiraling upward for another reason: the higher salaries earned by top city employees that follow them out the door when they retire. For example, former Police Chief Lynn Johnson retired after more than 30 years in 2009 with an annual pension of $201,953, and former City Manager Frank Benest isn't far behind with $193,351. Eighty-eight of the city's 954 retirees receive more than $100,000 a year, which does not include the cost of health care benefits for themselves and their family.

The city is making slow progress toward rolling back this trend by negotiating two-tier, less costly retirement packages with most unions that offer new employees fewer benefits than current rank-and-file workers. And the city is asking workers to pay more of their employee contribution to CalPERS. At a meeting in May when the council was discussing the long-range financial forecast, Vice Mayor Greg Scharff said that medical and pension costs are "running at an unsustainable rate and crowding out everything else."

"What we're asking people to do is accept a lower quality of life so that we can fund pensions and benefits that are growing at an outrageous pace. I don't accept that that should be the plan."

Scharff hopes a September city council discussion on pensions will get to the legal aspects governing the rights of employees and the city in pension matters. For example, could the city roll back a pension set at 2.0 at 55 to a 2.7 at 55 plan midway through a worker's career? This is a legal issue that has not been tested, Scharff said. The city is also handcuffed by restrictions put in place by CalPERS, which does not allow 401k-type plans and sets stiff penalties if the city wants to withdraw from the system, he said.

Voters would probably be ready to support efforts to roll back some of the city's pension commitments, similar to the decision to throw out binding arbitration for fire and police contracts, which was a major step for the city.

But at this time, it is not clear what options the city has to gain control of its pension costs, which are expected to grow faster than revenues in the years ahead. According to a Santa Clara County Civil Grand Jury report, the city's current pension liabilities are $153.9 million and its health care liabilities are $105 million, or $259 million in all. The total gives Palo Alto the dubious distinction of having the highest debt per resident in the county, at $4,021.

Clearly identifying its options and their legal risks needs to be a top priority for the city in the months ahead. In all likelihood, changes in both state law and city policy will be needed, since the progress being made in negotiating new labor contracts only slows down the growth of the problem. We look forward to a robust council discussion on the subject in September.

"Let he who is without lifetime 100 percent city-paid health benefits cast the first stone." - LaDoris Cordell

Posted by Frugal, a resident of Menlo Park
on Jul 20, 2012 at 10:36 am

Duhhh

Posted by registered user, FrankF, a resident of Ventura
on Jul 20, 2012 at 10:41 am

In 'good times' our pension system makes perfect sense - put off paying the retirement cost until later. This allows the city to pay less salary today because of the nice pension & health care benefit they offer and pay for the pension later - basically an interest free loan to the city.

But nothing is free - the expenses grow steadily but revenues sometimes don't.

To shift to a 401k style retirement shifts the risk of flat or declining investments values to the individual (how many of private sector workers have seen their 401k's basically flat for the last decade?). But the city would have to contribute to it today - raising costs now. That assumes we even could do that at all.

Tough choices...

Posted by longtimeresident, a resident of Old Palo Alto
on Jul 20, 2012 at 11:50 am

I am usually someone who is "for the people" but enough is enough. Pensions need to be cut back or discontinued. Or, I want one, too!

The ultimate market test is to put out an RFP for each of the city's services and see what the bids are for each. And contract out is paying as you go with no future pension liabilities.

Atherton did this and is saving millions.

Posted by lazlo, a resident of Old Palo Alto
on Jul 20, 2012 at 6:33 pm

...golly, if only the city had funded retirement benefits for contracts promised to employees. Too bad city officals didn't put money in reserve funds for employee retirement contracts when CalPERS required no reimbursement of funding, oh yeah, they did (or said they did) and then later placed these funds in unappropriated reserve funds. Guess it's simpler to hoard and hide than to honor contracts negotiated. With Palo Alto reserve funds exceeding $300,000,000, one has to wonder about the integrity of any city contract or do they intend to litigate each and every contract using the multi-million dollar reserve funds to secure legal advice on how to not pay their legal obligations. What a pity.

Posted by Really?, a resident of another community
on Jul 20, 2012 at 11:14 pm

Peter, are you really trying to draw a comparison between Palo Alto and Compton?

Palo Alto still has a AAA rating. It hasn't touched it's reserves. It's City Manager manufactures a deficit every year. He still has his Arizona "right to work" labor mentality.How much has Jim Keene spent on a PR firm to push his agenda?

It's pure fear mongering to keep bring up the bk word. And yes I'm including the new HR director.

Posted by Not the same peter as above, a resident of Downtown North
on Jul 21, 2012 at 1:32 am

It's not outrageous that 63% of the city budget is going to employment costs. I would imagine it's higher. The Weekly's story last week was full of errors and half-truths. Paying for pensions and retirement health care is a normal cost of doing business. When it comes to labor, this city is going backward. Two voices of labor on council, Sid Espinsoa and Yiaway Yeh, aren't seeking re-election. Thankfully, a strong voice for city employee unions, Marc Berman, is running this November. Hopefully more pro-labor voices will emerge in this race.

Posted by Wayne Martin, a resident of Fairmeadow
on Jul 21, 2012 at 7:11 am

> Palo Alto still has a AAA rating.

Just for the record, a AAA rating has virtually nothing to do with the management of the City, but reflects the ability of the tax base to pay off bonds that are sold by that government. The AAA rating has more to do with the prosperity of the people living in the jurisdiction of the rated governmental agency than anything else. And keep in mind that the management of the City governments almost always has nothing to do with prosperity/wealth of the people living in the governing agencies boundaries.

The AAA rating is about the property owners--not the government.

Posted by Wayne Martin, a resident of Fairmeadow
on Jul 21, 2012 at 7:37 am

> But, even more important, they made promises on pensions that
> were inappropriate and which there is no possible way for them to
> fund even if they cut all other local expenditures in half.

This is most certainly true. Pension obligations were not very visible in past yearslargely because of "local control", disinterested City Councils, and no national accounting standards for reporting these obligations to the public. The past decade has seen some very helpful GASB (Government Accounting Standards Board) changes introduced at the national level, which have helped to force local level governments to begin to document these liabilities. The financial meltdown has forced most governmental agencies to face these issues, since their pension funds have been making demands for more contributions, than in the past.

The following two short papers were submitted to local government, since I could not find much in their published financial documents about long-term pension obligations:

The Twenty-year Estimated Cost of Major Benefits For Palo Alto (CA) Government Employees:Web Link

Not one government official responded to these two papers, or any other communication I have made about pensions. I can only wonder if any of the elected Council members actually read, or understood, the data and implications of these projections?

The lack of standardized documentation about government pensions, as well as the obligations of the pension guarantees, has most certainly given cover to elected officials who were more interested in reelection, and/or wealth redistribution, than the long-term fiscal health of their respective agencies. And, once out of office, elected officials no longer can be considered as "responsible"the problem now belongs to someone else.

Certainly we will come to see the promises made by elected officials to guarantee pensions for tens of millions of public-sector employees as not only inappropriate, but fiscally irresponsible and possibly even criminally negligent, in the coming years.

And it hasn't even begun to cover its unfunded pension liability - which would wipe out the reserves.

Posted by Wayne Martin, a resident of Fairmeadow
on Jul 21, 2012 at 8:37 am

> And it hasn't even begun to cover its unfunded pension
> liability - which would wipe out the reserves.

Many of these so-called "reserves" are dedicated, I believe. Not certain that these reserve funds could be tapped to pay for pension obligations.

What is more likely is that the City would find a way to sell bonds to pay for these obligations that would not require voter approval. If memory serves, the County of Santa Clara did that long ago, to pay for some of its employee post-retirement benefits. There is an item on our property tax bills that documents the charge to property owners. Unfortunately, the Santa Clara County property tax bills are so difficult to read that some of the line items in the section on extra charges might not be readily understood by most folks.

Posted by Gouged In Midtown, a resident of Midtown
on Jul 21, 2012 at 11:03 am

Once again the expectation is that the average tax paying citizen can be gouged to support the outrageous promises made by vote seeking politicians to self-centered labor. I agree with Peter that the only reasonable solution to this problem is to start an RFP process that allows the city to implement a pay as you go system which is not only likely to produce significantly more motivated employees but also will help the city live within its means. Above all, this system will break the link between politicians and unions and will ultimately be the most fair system representing the tax payer.

The state's teachers union, Wisconsinites learned, had used its power to collectively bargain for healthcare benefits to demand that local school districts provide coverage through a nonprofit insurer affiliated with the union. Once the state ended bargaining on healthcare, school boards began competitively bidding out their health insurance.
By the opening of the new school year in September, just two months after the budget bill went into effect, 23 districts had rebid their contracts, saving $16 million, or an average of $211 per student. The MacIver Institute, a Madison-based think tank, estimated that if all the state's districts were able to negotiate similar deals once their contracts with the union-affiliated insurer expire, schools could save $186 million…
In mid-August 2011, barely a month after the changes went into effect, the Milwaukee Journal Sentinel reported that the city would save as much as $36 million in its next budget from "healthcare benefit changes it didn't have to negotiate with unions" as a result of the new state legislation.

Posted by The Party's Over!, a resident of Another Palo Alto neighborhood
on Jul 23, 2012 at 7:42 am

The craftier of the former administration got out of Dodge while the getting was good. Where was the leadership? Where was the accountability? Instead, the bloated, arrogant bureaucratic dons concentrated on feathering their own nests.

Posted by Wayne Martin, a resident of Fairmeadow
on Jul 23, 2012 at 1:54 pm

Although I believe that outsourcing is important to the future of "sustainable" local governments, there are other solutions that involve regionalization, then outsourcing.

Getting the political ducks in a row in order to regionalize will not be particularly easy, so the first step should be to consider outsourcing various departments/functions of Palo Alto government.

The following link is a Reason magazine article about outsourcing libraries here in California--

Standalone functions, like the library, could easily be outsourced. Contracts would be short--two to three years--to start, giving the City time to understand how to manage these new relationships, and not too long that if a mistake were made that it would have to wait very long for the contract to expire.

The first and biggest opportunity for consolidation is fire agencies. Orange County and SacMetro provide higher quality and lower cost fire and emergency response service than do any of the small agencies in Santa Clara and San Mateo counties. Eliminate duplicative overhead alone would save millions of dollars a year.

The Grand Jury learned during its investigation that the County has done the following to reduce
pension costs:

1. Obtained concessions from some unions during contract negotiations for their members to pay a larger portion of the employee contribution to SamCERA. For example, the California Nurses Association agreed that their members would forego 25% of the costof-living-adjustment increases, post retirement.
2. Developed plans to reduce the employer pick up for non-union employees. The Grand Jury understands that starting September 2012, the employer pick up will be reduced from 75% to 50% of the employee contribution for employees not covered by union contracts and, over the next several years, the employer pickup for this group will be
eliminated.
3. For new employees, reduced the existing pension benefits and increased the age at which they can be taken.
4. Based final retirement benefits on an average of the last two or three years of salary, rather on than on the last year alone.
5. Reduced the number of County employees through staffing efficiencies, by not filling vacant positions, or by eliminating or outsourcing services.
---

While this Grand Jury was looking at pensions, it does not take much investigation to see that the size of the pension obligation is directly linked to the size of the government operation. Reducing head count, reorganizing and merging operations is clearly one way out of this mess.

Does San Mateo County Need 13 Separate Police Dispatch Centers?
This same Grand Jury looks to the future, suggesting consolidation of some police functions--

Grand Juries have no real "teeth", and often miss the mark when it comes to suggesting "best practices". That said, they do represent the viewpoint of the general population, more-often-than-not bringing common sense to the review of government organization, service delivery, and public expenditures. It will be interesting to see the County's response to these Grand Jury reports. It will also be interesting to see if Palo Alto shows any interest in this Grand Jury's recommendations for its own operations.